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The Definitive Silver ETF Guide: Silver ETF Investing 101

by Eric Dutram on November 12, 2009 | ETFs Mentioned: AGQ • DBS • SLV • USV • ZSL

While most investors are well aware of gold’s unprecedented march to $1,100/oz., far fewer are familiar with the yellow metal’s often overlooked cousin, silver. While gold has received a great deal of attention as a hedge against the U.S. dollar, the leading silver ETF, SLV, has outperformed its gold counterpart, GLD, by a factor of 2 to 1 in 2009. Although silver has flown under the radar (thanks in large part to its price of around $17/oz.), many investors consider the metal to be a sound investment due to robust industrial demand, its traditional role as a store of value, and its current ratio compared to gold. These three factors will help to ensure that despite silver’s volatility, there will always be demand for this “forgotten precious metal.”

In any case, silver ETFs are an efficient way to invest in the metal without dealing with the associated “headaches” of holding a physical amount of silver in your possession. Below is a guide to silver ETF options for investors looking for precious metal exposure that goes beyond gold.

How a Silver ETF Works

Silver ETFs can either directly hold silver bullion (the iShares Silver Trust – SLV – does this), or invest in d Silver Coin erivatives that track the price of silver (for instance, the PowerShares DB Silver Fund – DBS - holds futures contracts). Both types of ETFs will move with the price of silver, and similar types of silver ETFs usually have similar expense ratios.

Industrial Demand

Silver has a wide variety of industrial uses, effectively establishing a floor for demand (something that gold lacks). Over 40% of all silver is used for industrial purposes, including uses in photography, batteries and CDs, and Plasma TVs. Silver is also fast becoming a critical component of emerging technologies that will undoubtedly be critical to life in the 21st century. Silver plays a crucial role in solar technology, finding its way into 90% of all crystalline silicon photovoltaic cells, as well as silver embedded bandages and water purification devices. Due to the extreme diversity of the applications for silver, it should be one of the metals least affected by a continued industrial slump. Since gold is primarily used for electronics, copper for housing and construction materials, and platinum with automobiles, their prices are much more correlated to individual industries, while silver has a wide variety of uses that stretches across all facets of the economy.

ETFdb Pro members can gain more insights into the drivers of precious metals prices in our ETFdb Category Report (if you’re not a Pro member yet, you can sign up for a free trial or read more here).

Poor Man’s Gold

As the emerging economies of the world continue to lose faith in the U.S. dollar, investors are looking to buy assets that are not dependent on the full faith and credit of the United States government. While many emerging markets have historically considered Treasuries to be a store of value, that is no longer the case. As emerging economies get richer, both individual citizens and governments are looking to reallocate their reserve holdings hard currencies. With a price that is currently less than $20/oz., silver is a relatively cheap and easy way to diversify assets out of fiat money without having to deal with buying 1/10 of an ounce gold coins. As such, silver should remain a popular choice for global investors looking for a safe haven and store of value.

Gold to Silver Ratio

In the 1972 Currency Act, the U.S. set the gold/silver ratio at 1/15, meaning that one troy ounce of gold would buy 15 ounces of silver. While banknotes are no longer convertible into silver, this historical ratio has become extremely distorted in the 20th century hitting an average of 1/47 for the past century. If the ratio were to return to its 20th century mean and gold prices did not change from their current levels of $1,110 an oz., that would require silver prices to increase to almost $24/oz. If the ratio were to go to its geological ratio, silver would have to rise to an unfathomable $74/oz. While it’s unlikely that the price of silver will hit this mark anytime soon, the fundamentals are certainly in the metal’s favor for continued price appreciation going forward (for a complete guide on Gold ETFs, click here).

Too High Too Fast?

While the price of silver has gone up tremendously over the past year, the fact remains that it can be a volatile precious metal susceptible to large price swings in a short period of time. As presented in the chart below, investors in silver have been on a wild ride over the past three years. With prices crashing nearly 50% from their highs in 2008, and then nearly rebounding all the way back to the 2008 highs, investors cannot assume that a similar situation will not happen again in the future. Should financial markets experience more upheaval in the future, and if investors lose even more faith in fiat currencies, expect silver to continue its roller coaster ride.

SLV

Ways to Play

There are several ways for investors to play silver with ETFs. The most popular is iShares Silver Trust (SLV) followed by ETF Securities Silver Trust (SIVR) and then the PowerShares DB Silver Fund (DBS). While the iShares fund is the most liquid, the ETF Securities fund has an expense ratio that is 20 basis points lower. For investors who are especially bullish on silver, ProShares Ultra Silver (AGQ), which seeks to deliver daily returns equal to twice the daily return on silver, represents an appealing short-term choice. ProShares also offers the UltraShort Silver ETF (ZSL), which offers inverse leveraged exposure to silver prices.

For investors looking to gain exposure to both gold and silver through one security, there are several options available, including the iPath Dow Jones-AIG Precious Metals Total Return Sub-Index ETN (JJP) and PowerShares DB Precious Metals Fund (DBP). Both of these ETFs invest in both precious metals, but give a significantly higher weighting towards gold. For more ETF guides, make sure to sign up for our Free ETF Newsletter.